Educational Articles

Electric Utility Stocks have long been a favorite of income-oriented investors, and for good reason. The average yield of stocks in this industry is currently 4.0%, well above the Value Line mean of 2.5%.

Although current income is the primary allure for most electric utility investors, these companies have other attractive aspects, including their defensive nature. In difficult economic times, consumers may run their air conditioners less, but they still want to keep the lights on. Indeed, most electric utility stocks are less risky, and less volatile, than nonutility issues, as evidenced by their average beta of .71. Still, this is certainly not to say that they’re risk free —no investment is. Of course, there are tradeoffs. Although these issues are well suited to risk-conscious income investors, capital appreciation is usually limited, making them unfit for growth accounts.

To create our list, we ran a simple screen of stocks in the Electric Utility industry to find those with yields of at least 4.0%. We also required that all issues were trading above $5.00 a share, and to help ensure the dividends were sustainable, we limited the results to those companies with long-term debt as a percentage of total capital below 50%. Investors should keep in mind that stocks with a high yield are not necessarily more attractive than those with a low yield. The yield is a measure of valuation, and a high yield simply indicates that the stock is cheaper, not necessarily better. Indeed, a significantly above-average yield on an Electric Utility stock is often an indication that there is at least one matter of concern with the company. Our screen returned 19 names (see list below), of which, we have chosen to highlight American Electric Power (AEP) and Pepco Holdings (POM).

American Electric Power

American Electric Power is one of the largest electric utilities in the United States. It owns over 40,000 megawatts of generating capacity and the nation’s largest electricity transmission system, a 39,000 mile network serving over 5 million customers in Arkansas, Kentucky, Indiana, Louisiana, Michigan, Ohio, Oklahoma, Tennessee, Texas, Virginia, and West Virginia.

Most of the company’s utilities earned an adequate return on equity in the past year. A notable exception is Indiana & Michigan Power, but its results will improve following an $85 million rate hike that took effect in February.

There are several growth engines in place for AEP. For one, rate relief is a key reason why we expect higher earnings in 2013. Electric transmission is also a source of growth for AEP. Allowed ROEs for transmission investment are attractive. In fact, much of the profit growth we expect in 2014 can be attributed to transmission.

Recently, AEP’s board of directors increased the dividend for the first time in more than a year. The increase was (4.3%) quarterly. AEP is targeting a payout ratio of 60%-70%, up from the previous 50%- 60%. This reflects the fact that, an estimated 86% of corporate profits will come from regulated operations. This stock’s dividend yield of 4.7% is currently 70 basis points above the utility average. Total return potential to 2016-2018 is higher than the utility average, as well.

The Washington, DC-based utility recently reported slightly worse-than-expected earnings during the second quarter, largely due to weak load growth. Despite the slight miss, the company reaffirmed its full-year earnings guidance range.

Nonetheless, management cautioned that potential regulatory changes continue to be somewhat of a burden. On July 12th, the company received yet another lackluster regulatory ruling in its electric distribution rate case in Maryland. The commission’s order authorized a $28 million increase in rates, less than half of the amount requested in Pepco’s initial filing.

Shares of Pepco are currently yielding an attractive 5.7%, well above the utility industry’s 4.0% mean. Based on its steady earnings, the payout appears well covered over this time. By utility standards, total return potential to 2016-2018 is also above average.

Company

Ticker

Dividend Yield

Pepco Holdings

POM

5.71

Southern Co.

SO

4.94

Hawaiian Elec.

HE

4.94

Ameren Corp.

AEE

4.76

Integrys Energy

TEG

4.75

Duke Energy

DUK

4.73

Avista Corp.

AVA

4.72

Amer. Elec. Power

AEP

4.69

Empire Dist. Elec.

EDE

4.58

Public Serv. Enterprise

PEG

4.46

Consol. Edison

ED

4.44

PG&E Corp.

PCG

4.39

Westar Energy

WR

4.37

Vectren Corp.

VVC

4.3

Otter Tail Corp.

OTTR

4.28

Pinnacle West Capital

PNW

4.12

G't Plains Energy

GXP

4.06

ALLETE

ALE

4.06

Exelon Corp.

EXC

4.04

At the time of this article's writing, the author did not have positions in any of the companies mentioned.